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Edited Transcript of PTC earnings conference call or presentation 22-Jan-20 10:00pm GMT

Q1 2020 PTC Inc Earnings Call

NEEDHAM Jan 24, 2020 (Thomson StreetEvents) -- Edited Transcript of PTC Inc earnings conference call or presentation Wednesday, January 22, 2020 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* James E. Heppelmann

PTC Inc. - President, CEO, Member of National First Executive Advisory Board & Director

* Kristian P. Talvitie

PTC Inc. - Executive VP & CFO

* Timothy M. Fox

PTC Inc. - VP of IR

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Conference Call Participants

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* Adam Charles Borg

Stifel, Nicolaus & Company, Incorporated, Research Division - Associate

* Alexander William Tout

Deutsche Bank AG, Research Division - Research Analyst

* Andrew Lodovico DeGasperi

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Hoi-Fung Wong

Guggenheim Securities, LLC, Research Division - Senior Analyst

* Jason Vincent Celino

KeyBanc Capital Markets Inc., Research Division - Associate

* Jay Vleeschhouwer

Griffin Securities, Inc., Research Division - MD of Software Research

* Kenneth Richard Talanian

Evercore ISI Institutional Equities, Research Division - Analyst

* Matthew Fraser Broome

Mizuho Securities USA LLC, Research Division - VP of Americas Research

* Matthew George Hedberg

RBC Capital Markets, Research Division - Analyst

* Saket Kalia

Barclays Bank PLC, Research Division - Senior Analyst

* Sterling Auty

JP Morgan Chase & Co, Research Division - Senior Analyst

* Steven Richard Koenig

Wedbush Securities Inc., Research Division - MD

* Tyler Maverick Radke

Citigroup Inc, Research Division - Senior Associate

* Yun Suk Kim

Rosenblatt Securities Inc., Research Division - Senior Software Research Analyst

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Presentation

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Operator [1]

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Good afternoon, ladies and gentlemen. Thank you for standing by, and welcome to the PTC 2020 First Quarter Conference Call. (Operator Instructions) Today's conference is being recorded. (Operator Instructions) I would now like to turn the call over to Tim Fox, PTC's Senior Vice President of Investor Relations. Please go ahead.

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Timothy M. Fox, PTC Inc. - VP of IR [2]

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Thank you, Sheila. Good afternoon, everyone, and thank you for joining PTC's conference call to discuss our fiscal Q1 '20 results. On the call today are Jim Heppelmann, Chief Executive Officer; and Kristian Talvitie, Chief Financial Officer.

Before we get started, please note that today's comments include forward-looking statements, including statements regarding future financial guidance. These forward-looking statements are subject to risks and uncertainties and involve factors that could cause actual results to differ materially from those expressed or implied by such statements. Additional information concerning these factors is contained in PTC's filings with the SEC, including our annual report on Form 10-K and quarterly reports on Form 10-Q.

As a reminder, we'll be referring to operating and non-GAAP financial measures during today's call. Discussion of our operating metrics and these items excluded from our non-GAAP financial measures and a reconciliation between GAAP and non-GAAP financial measures are included in our earnings press release and related Form 8-K.

Lastly, references to growth rates will be in constant currency unless otherwise noted. And with that, let me turn the call over to Jim.

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James E. Heppelmann, PTC Inc. - President, CEO, Member of National First Executive Advisory Board & Director [3]

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Thanks, Tim. Good afternoon, everyone, and thank you for joining us. I'm pleased to share that our solid Q1 performance puts us right on track to deliver against our fiscal '20 targets and our attractive long-term financial ranges.

ARR, which is our key top line metric, grew 11% in Q1. As Kristian will detail later in the call, we are raising our fiscal '20 ARR guidance based on our Q1 performance, our visibility into the balance of the fiscal year and favorable currency tailwinds. We're also raising revenue, EPS and adjusted free cash flow guidance for the year.

At the midpoint of our guidance, we're now expecting fiscal '20 ARR growth in the mid-teens, revenue growth approaching 20% and EPS growth above 40%. The benefits of all the hard work we've done in the past years to expand our profitability, to increase our growth rate and to convert to a subscription model are really starting to show because PTC truly is emerging as one of the world's premier public software companies.

Before digging into the details, I'd like to share some observations about broader industry trends and PTC's unique position in terms of helping customers thrive during this period of rapid change in the industrial world. Similar to other industries like entertainment, hospitality or transportation that have been disrupted by digital technologies, industrial companies are now facing new challenges from traditional competitors that are embracing digital technologies across the value chains and from new entrants exploring new business models.

Digital transformation has become a wave that's sweeping across the industrial market, enabling companies to better differentiate their products and services while simultaneously optimizing their engineering, manufacturing, sales and service processes. As the only company out there who has a suite of CAD, PLM, IoT, AI and AR capabilities, PTC has a unique ability to help customers pursue their digital transformation ambitions. Every day, we're helping customers to do things like implement AI-driven product design or to create a digital thread to leverage product data across the value chain or to gain operational insight from their products in the field and their assets, in their factories, through our leading IoT and AI technology and to drive significant improvements to worker productivity through our AR technology. I host many customer meetings, and I can tell you that PTC solutions really resonate with our customers because they align with their high priority initiatives.

Nobody else looks like PTC. And with the opportunity in front of us, it's a very exciting time to be here.

Given our performance and forward-looking momentum, one should take note that traditional economic measures like the PMI index are now much less correlated with PTC business trends. As we all learned in the great recession of 2009, recurring revenue streams are impacted much less by economic fluctuations than is perpetual license revenue. This suggests that our subscription-based business model, coupled with growing secular dynamics of our business that I described earlier, have to a large degree driven a decoupling from traditional cyclical measures like PMI. We are guiding to strong ARR growth against the backdrop of some of the most lackluster PMI numbers in recent memory. Of course, we remain mindful of these external measures, but this negative sentiment has been around for some time now. This decoupling gives us even more confidence in our ability to drive sustainable growth going forward.

Turning now to some highlights in the quarter. I'll begin with our Growth business that now includes ThingWorx IoT, Vuforia AR and Onshape SaaS. ARR growth for our IoT solutions accelerated quarter-over-quarter, and our augmented reality solutions once again outpaced high market growth rates, thanks to a continuation of the trend of customers introducing AR into their manufacturing and service environments. In addition to healthy new logo activity, Q1 expansion bookings represented about 65% of IoT and AR bookings, primarily driven by customers shifting from pilots to production at an accelerating pace. The number of 6-figure deals in the quarter more than doubled versus a year ago.

When viewed through an ARR lens, trends across our customer cohorts are impressive. Relative to Q1 of last year, the number of IoT and AR customers with ARR greater than $500,000 grew by over 50%. One of these customers, Thermo Fisher, is a great example of how enterprises are transforming their business with PTC solutions. Thermo Fisher is a global leader in the biotech space, who's leveraging ThingWorx to offer new value-added services to further differentiate themselves in their competitive end markets.

In their chemical analysis division, for example, Thermo Fisher embeds ThingWorx within their products, allowing end customers to remotely capture and analyze test data from these products. Thermo Fisher is also leveraging ThingWorx for predictive maintenance and to provide feedback loops to their product development teams. Thermo Fisher is representative of the trends we're seeing where customers are expanding their digital footprint across product lines and use cases and into their production environments as well.

Given the broad scope and global nature of digital transformation opportunity within the industrial market, we knew it would be challenging to pursue this alone. Of course, that's why we performed strategic alliances with industry leaders like Rockwell Automation and Microsoft. Both of these alliances again delivered the goods in Q1.

In our Rockwell Automation alliance, Q1 provided a strong start to the year with robust new deal activity plus a meaningful uptick in expansions as pilot projects that were kicked off earlier in FY '19 moved into production. The Rockwell alliance team delivered new deals across the broad cross-section of vertical markets and in 15 different geographies, which highlights both the deep industrial domain expertise and the global reach that Rockwell Automation brings to this relationship.

In our Microsoft alliance, Q1 also marked a strong start to the year with new ACV bookings well above plan. Geographically, the Americas continues to be the main driver of growth. However, momentum in Europe is building, and the Microsoft alliance has a robust pipeline heading into Q2.

We're also pleased to see that demand continued to expand beyond the smart connected product use case into factory and even AR solutions, which represented more than 1/3 of the alliance bookings in Q1. A great proof point of the power of our Microsoft alliance is a recent win at Johnson Controls, who is a leading global provider of building control systems. It turns out that PTC, Microsoft and Accenture were independently supporting JCI's digital transformation efforts from different angles. Too many cooks in the kitchen ran the risk of slowing things down. So PTC, Microsoft and Accenture joined forces and approached the C-suite with a unified strategy for their smart factory initiatives. Together, we landed the deal to deliver a fully cloud-based smart factory solution that has Accenture deploying PTC's ThingWorx on Microsoft's Azure.

Before I leave the growth discussion, let me share that we're making great progress integrating the Onshape team. In fact, the Onshape team moved into our Seaport headquarters earlier this week. I like to think of Onshape as the proverbial iceberg. What you see above water, the 5%, looks a lot like a next-gen CAD and PLM system. But what's below the water, the 95%, is PTC's new pure SaaS platform. We have big plans for Onshape and for SaaS, and I'm convinced this will become another major growth engine for PTC.

While it's too early to say much yet, I look forward to updating you on our SaaS progress in coming quarters.

Our Core product group delivered strong Q1 performance as well. Core business ARR growth of 10% outpaced market growth again in the quarter. It was led by very strong performance in PLM, which delivered mid-teens ARR growth that reflected broad-based strength across all major geographies. In my view, the strong performance in PLM is indicative of the growing strategic role that PLM technology now plays in our customers' digital transformation strategies. Any industrial company who wants to undertake a digital transformation quickly realizes that PLM will need to be one of their anchor tenant systems of record.

Take Groupe Beneteau, a French manufacturer who's a leader in luxury sail and powerboats. By leveraging PTC's Windchill along with Creo and ThingWorx and Vuforia, Beneteau is delivering product and service differentiation together with engineering excellence and operational efficiency. Their PLM technology road map began with foundational capabilities such as bill of material management and change management, then extended into the factory with concurrent engineering and manufacturing instructions and, from there, into leveraging AR functionality for shop floor operators and dealership scenarios. This powerful combination of highly differentiated technologies is truly unique to PTC. We're using it to win new business and to expand relationships with existing customers as they seek to modernize their business processes. Altogether, we're seeing more and more evidence of a rejuvenation of PLM that makes the long-term growth opportunity that much more attractive for PTC.

Our CAD team had a solid start to the year too, again delivering high single-digit ARR growth with notable strength in Asia Pacific and in our global reseller channel. On the Creo Simulation Live front, which is the starting point for our ANSYS partnership, interest remains high. Adoption, particularly in the enterprise space, continues to ramp nicely with average deal sizes continuing to grow. Our focus on Creo Simulation Live, or CSL as we call it, in FY '20 is on driving adoption in the channel, which generates about half of our CAD business. We're kicking off new channel enablement and promotional programs in Q2 and remain bullish on the long-term opportunity for significant CSL penetration in our installed base.

While CSL is the tip of the spear in our partnership with ANSYS, we're also making good progress bringing the broader Discovery AIM suite into the Creo fold as well.

To wrap up my comments, I'd like to reiterate PTC's full commitment to driving mid-teens ARR growth and generating significant free cash flow in the coming years. Our strong performance in CAD and PLM, plus our leadership positions in the high-growth IoT and AR markets and more new opportunities for growth in the SaaS-based product development market with Onshape, gives us strong confidence that our growth will remain both significant and sustainable over the long term.

With our subscription transition in the rearview mirror and our ongoing focus on disciplined cost and portfolio management, we're firmly on track with our plans to transform PTC into one of the premier public software companies in the world.

And with that, I'll turn it over to Kristian to comment on financials and guidance.

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Kristian P. Talvitie, PTC Inc. - Executive VP & CFO [4]

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Thanks, Jim, and good afternoon, everyone. Before I review our results, I'd like to note that I'll be discussing non-GAAP results and guidance, and all growth rate references will be in constant currency.

Let me start off with a review of our first quarter results. Again, this quarter, I'm going to keep my remarks brief, hitting just some key highlights and ask investors to refer to our press release and prepared remarks document available on our IR website for additional details.

Q1 ARR was $1.16 billion, representing 11% year-over-year growth, which is consistent with the guidance commentary we provided last quarter. ARR in our Growth product group was up 36% year-over-year, and we continue to expect ARR growth to be above-market growth rates of 30% to 40% in fiscal '20. ARR in the Core was up 10% year-over-year, which was also above market growth and consistent with our outlook for fiscal '20. ARR in FSG was up 1% year-over-year, primarily due to the timing of deals, and we expect ARR growth to be in the low to mid-single digits for FSG for fiscal '20.

Total Q1 revenue of $356 million was up 8% year-over-year despite a 78% year-over-year decrease in perpetual license revenue driven by the end of perpetual license sales on January 1, 2019. Operating margin of 26% increased 200 basis points over Q4 '19 and declined 100 basis points compared to Q1 '19 where we experienced higher-than-expected perpetual license revenue resulting from the perpetual end-of-life program.

And lastly, non-GAAP EPS of $0.57 increased 5% year-over-year against the perpetual heavy comparison of last year. And as you'll recall, revenue and operating expenses and, consequently, EPS can be impacted positively or negatively by ASC 606. Major drivers impacting revenue include term length changes and support to subscription conversion. And on the OpEx side, commissions are obviously also impacted. Finally, our Q1 adjusted free cash flow of $12 million was within our expectations and sets us up to achieve our full year guidance.

Now turning to the guidance. Beginning with ARR, for fiscal '20, we're increasing our guidance to a range of $1.27 billion to $1.29 billion or 14% to 16% year-over-year growth and 13% to 15% on a constant currency basis. ARR guidance includes approximately $15 million of positive FX. And already embedded in our original guidance for the year is approximately $10 million of ARR or 1 point of growth from the Onshape acquisition. Consistent with our prior guidance commentary, we expect Q2 constant currency ARR growth to be in line with Q1 results with ARR growth rates accelerating in the back half of the year. This increase is driven by both normal seasonality of our business and our backlog of deals booked in prior periods.

Now turning to adjusted free cash flow. For fiscal '20, we're expecting a range of $260 million to $280 million, reflecting the positive FX impact of $5 million.

Now turning to P&L guidance. We're now expecting fiscal '20 total revenue of $1.45 billion to $1.53 billion, an increase of $25 million at the midpoint of guidance, reflecting our Q1 performance, our outlook for the remainder of the year and approximately $15 million of FX.

Non-GAAP EPS is now expected to be $2.15 to $2.65, an increase of $0.12 at the midpoint of guidance, reflecting our Q1 performance and outlook and $0.05 of FX. We continue to expect fiscal '20 operating expenses to grow approximately 9% year-over-year.

With that, I'll turn the call over to the operator to begin the Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

Our first question comes from Matt Hedberg with RBC Capital Markets.

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Matthew George Hedberg, RBC Capital Markets, Research Division - Analyst [2]

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PLM ARR growth mid-teens constant currency was pretty good. I know you called out pretty good geographic success. I think in your press release, you talked about China and Europe, in particular. And Jim, you mentioned digital transformation being a real tailwind here. Could you talk about the sustainability of this PLM growth? I know we spent a lot of time on some of the growth of your businesses. But sort of the durability of PLM as we look forward through this year.

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James E. Heppelmann, PTC Inc. - President, CEO, Member of National First Executive Advisory Board & Director [3]

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Well, I think we're going to have a very strong year this year for sure. And I think if you remember back to September, Kristian said over the coming 5 years, we would expect our PLM ARR growth rate to slow down to the market growth rate, which I think you had at 8%?

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Kristian P. Talvitie, PTC Inc. - Executive VP & CFO [4]

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Yes.

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James E. Heppelmann, PTC Inc. - President, CEO, Member of National First Executive Advisory Board & Director [5]

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Yes. So we're sort of mid-teens. And we think, over the 5 years, that will slow to 8%. Now that's based on a number of factors. One thing is our renewal rates and PLM are very high. This is very, very sticky software. And relative to the base of ARR, we're selling a lot of it. So we're really in a strong, good situation where there is strong demand because of digital transformation. Our product is ranked #1 by every analyst report I've ever seen. And so we're in a good strong position where we get a chance to meet that demand with our product and high renewal rates, and that bodes well for a long time to come.

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Operator [6]

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Our next question comes from Jay Vleeschhouwer with Griffin Securities.

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Jay Vleeschhouwer, Griffin Securities, Inc., Research Division - MD of Software Research [7]

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With regard to PLM, following up on that subject. When we think back over the last 12 to 15 years or more, there seems to have been a pendulum of adoption among customers. In other words, there have been times when PLM-only companies seem to have had momentum. And then there are times when the integrated engineering software companies that have CAD and PLM and perhaps other products have had momentum. The question therefore is, what are you seeing in terms of conjoined business or CLM business across your 3-letter acronyms? How much of the PLM business is just for PLM versus your being able to conjoin CAD or anything else to that either as a beneficiary or driver to the PLM business?

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James E. Heppelmann, PTC Inc. - President, CEO, Member of National First Executive Advisory Board & Director [8]

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Yes. I think there have been pendulums for sure. And one of the strong upswings was when PTC, who at that point had a CAD footprint, brought PLM into the picture and cross-sold a lot of PLM to the CAD audience.

Now I think what's happening this time is a couple of different drivers. One is we're doing a lot more engineering into manufacturing data transformation. We have the software module of our PLM system called MPMLink as in Manufacturing Process Management. And it's used to convert an engineering design and an engineering bill of material into a manufacturing process design and instructions and a manufacturing bill of material in a very systematic, configuration-managed sort of way so that if somebody later decides to change the engineering design, we can pinpoint what they need to update in the manufacturing process very quickly. And if the engineering design is highly configurable. Well, it turns out, so are the manufacturing instructions and the MBOMs.

So today, we're selling a lot into that. That's become a new driver, an incremental new driver. And then the other thing is customers are really realizing, for example, this augmented reality technology, which we have best-in-class, customers love it, it's selling like crazy, that stuff needs configuration management of its content. So a lot of customers, and I'm thinking of a great, big -- I won't name them because they didn't -- I didn't ask if I could, but a great, big truck company in Europe really is excited about our AR technology. And what it's produced is a PLM project. Because they say, "All right, that's great, but we'll never really be able to do augmented reality without configuration management of the content. So let's go do this broader PLM project." So I think that's another driver. I'd put that one also in kind of the digital transformation category. So I think there's definitely an upswing, but it's really brought by people saying, "How could you have a digital transformation strategy without having the digital descriptions of your products and manufacturing processes under control?" It's silly to even talk about that. So I think this has definitely produced a tailwind that's generating momentum for PLM.

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Operator [9]

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Our next question will come from Ken Talanian with Evercore ISI.

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Kenneth Richard Talanian, Evercore ISI Institutional Equities, Research Division - Analyst [10]

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Could you give us a sense for how your net retention rate trended in the quarter for Core, Growth and FSG compared to last year?

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Kristian P. Talvitie, PTC Inc. - Executive VP & CFO [11]

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Yes. Ken, it's Kristian. I think we're not going to get into the quarterly variability, again, just given the reporting framework that we have. But I think, suffice it to say, that given the guidance that we have for the year, we're expecting -- continuing to expect a modest improvement in net retention here in fiscal '20.

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Kenneth Richard Talanian, Evercore ISI Institutional Equities, Research Division - Analyst [12]

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Great. And I guess as a follow-up. It looks like the Growth portfolio saw some good traction in both Europe and APAC. Could you give us a sense for how we should think about the sustainability of that Growth portfolio in both those regions?

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James E. Heppelmann, PTC Inc. - President, CEO, Member of National First Executive Advisory Board & Director [13]

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Yes. I mean I think what normally happens here at PTC, maybe elsewhere, but here at PTC when we launch a business, a new business, it gets traction first in the U.S., and then over time, it gains more and more traction in Europe and APAC. And so I think that's just a natural way that these businesses develop, and we see it happening here. So a lot of times, they get stronger first in the U.S. And then without the U.S. necessarily weakening, Europe and Asia come on stronger a little bit later. That's what I would attribute that to.

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Operator [14]

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Our next question comes from Saket Kalia with Barclays.

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Saket Kalia, Barclays Bank PLC, Research Division - Senior Analyst [15]

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Kristian, maybe for you, a bit of a mechanical question. But can you just talk a little bit about ramped deals? We talked about them a little bit last quarter. You've talked a little bit about sort of the back half strength that we should see in ARR for a variety of reasons. It sounds like ramp deals are part of it. Can you just touch on what parts of the business are you seeing these types of deals, these ramp deals? And then just for the benefit of the broader group, can you just talk about how they impact ARR at sort of different points in that ramp? Does that make sense?

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Kristian P. Talvitie, PTC Inc. - Executive VP & CFO [16]

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Yes. Sure, Saket. It's a good question. So thanks. If we just delve into the mechanics of it, how ramp deals impact ARR is we will add things to ARR on start date of the contract, right? Not book date. Start date. And in the case of a ramp deal, where you have in essence kind of multiple start dates that you have year 1 of, whatever, 100,000...

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Saket Kalia, Barclays Bank PLC, Research Division - Senior Analyst [17]

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Yes. Can I give an example and then you talk about the mechanics?

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Kristian P. Talvitie, PTC Inc. - Executive VP & CFO [18]

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Sure.

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Saket Kalia, Barclays Bank PLC, Research Division - Senior Analyst [19]

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Let me just lay out an example. Let's say a customer loves our smart factory solution, and they have 20 factories. And so they say, I want to really understand what is going to cost me across all 20 factories. So I'd like to negotiate a deal for 20 factories. But I can only get about 5 deployed in the first year. Let's say, another 5 in the second year. And 10 in the third year.

So they're going to do a ramp, that's a commitment: the 5 the first year; 5 plus 5, the second year; and 5 plus 5 plus 10, the third year. So that's the ramp of the commitment, how many units added.

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Kristian P. Talvitie, PTC Inc. - Executive VP & CFO [20]

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And so the way that, that would flow into ARR is we would take the first 5 factories' worth in year 1. In, say, year 2, when the next 5 comes on, we would take the incremental 5 factories. And then in the third year, we would take the incremental 10. So that's the mechanics of it. ARR flows in on start date of the contractual commitment.

In terms of where we're seeing ramp deals, we see, I would say, more of them in the Growth product group, IoT, AR. And then we still actually do see some in Core as well, but to a lesser extent, and the least extent in any of the FSG products.

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Operator [21]

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Our next question comes from Matthew Broome with Mizuho Securities.

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Matthew Fraser Broome, Mizuho Securities USA LLC, Research Division - VP of Americas Research [22]

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I'm just curious, how are you tracking for sales capacity so far versus your hiring plans this year. And can you sort of give us any kind of an update on what sort of percentage of your total capacity is now focused on IoT and augmented reality?

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Kristian P. Talvitie, PTC Inc. - Executive VP & CFO [23]

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So if the question -- sorry, I'm just going to repeat it to make sure that I understood it. I think the question was how are we tracking in terms of sales capacity was step 1. And then step 2, how is that capacity divided between Growth and Core and FSG?

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Matthew Fraser Broome, Mizuho Securities USA LLC, Research Division - VP of Americas Research [24]

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Yes, exactly.

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Kristian P. Talvitie, PTC Inc. - Executive VP & CFO [25]

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Yes. Great. So in terms of tracking the capacity, I think we are on track for hiring, kind of right where we would like to be at this point given our plan. In terms of the spreads, frankly, I'm going to have to get back to you on specific details, but the majority is actually still on the Core product set, which is understandable, an increasing amount on IoT and then still specialists focused on the various components of FSG.

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James E. Heppelmann, PTC Inc. - President, CEO, Member of National First Executive Advisory Board & Director [26]

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Yes. I mean another way to look at it would be to look at sales productivity, which would be lowest in the Growth business because growth -- you're bringing on a lot of new capacity, and it's doing a lot of land and expand deals and so forth. It would be significantly higher in the Core and maybe even higher yet in the Focused Solutions Group.

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Kristian P. Talvitie, PTC Inc. - Executive VP & CFO [27]

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It gets a little more complicated where you have -- we also have full product line reps, right, reps who are focused on major accounts, and they sell everything in the bag. So like how you want to break that out, it can get a little bit complicated.

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James E. Heppelmann, PTC Inc. - President, CEO, Member of National First Executive Advisory Board & Director [28]

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But a basic takeaway would be that capacity is overrepresented for the Growth business, right, which is what we need to do to deliver the growth.

And back to the hiring thing, I can certainly understand where that question comes from. You should know we -- after about a year ago, when we did get behind the capacity, we changed the way we looked at this. We used to think of capacity as being a fiscal year thing. And now we think of it really as every quarter. So it's not like this year, we have this many heads. But it's more like a constant. Every quarter, we need to be bringing on more capacity so that we don't end the year and then have a big step function of capacity we have to ramp going into the next year. So I think our processes are vastly improved in this area.

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Operator [29]

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Our next question comes from Andrew DeGasperi with Berenberg.

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Andrew Lodovico DeGasperi, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [30]

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Maybe if I could ask about the ARR guidance increase. Can you maybe explain to us the components of that? I guess Onshape is a big one, but are there deal timing pushouts that happened from Q4 to Q1, FX, can you maybe quantify that a little further?

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Kristian P. Talvitie, PTC Inc. - Executive VP & CFO [31]

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Yes. Sure. So this is Kristian. Let's start with Onshape. Onshape was already embedded in our initial guidance which we provided last quarter.

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James E. Heppelmann, PTC Inc. - President, CEO, Member of National First Executive Advisory Board & Director [32]

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After the acquisition was announced.

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Kristian P. Talvitie, PTC Inc. - Executive VP & CFO [33]

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After the acquisition was announced, but provided in the initial guidance. So it's about $10 million from Onshape. There's about a $15 million increase from favorable FX as well. And then it just -- we're now 1/4 of the way through the year. And we delivered what we believe are very solid results for Q1 and feel that much more comfortable with the range that we have out there.

So in essence, what we did was tighten up the bottom end of the range from 12% to 15% to 13% to 15% and then increased the range from 13% to 15% to 14% to 16% really based on the FX impact. So hopefully, that helps.

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Operator [34]

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Our next question comes from Ken Wong with Guggenheim Securities.

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Hoi-Fung Wong, Guggenheim Securities, LLC, Research Division - Senior Analyst [35]

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Okay. You're very positive on just the trajectory of Onshape. And obviously, you guys have more things to come and announce. It sounds like, so far, we've had a lot of feedback in terms of how maybe your customers are receiving it. Can you give us a little bit of color in terms of how the Onshape side of the installed base is looking at the PTC portfolio?

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James E. Heppelmann, PTC Inc. - President, CEO, Member of National First Executive Advisory Board & Director [36]

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Yes. I mean I think the first thing we focused on was to make sure that the Onshape customers felt that it was a good thing that PTC acquired Onshape. Just even if they stop there. And I think we've been very successful there. The messaging we put out there was very supportive of Onshape and its importance to our future strategy. And of course, CAD is very sticky software that companies tend to use for a lot of years. So if you're using Onshape, you want to make sure it's in a sustainable place so that you don't end up finding it's being shut down some years down the road or something like that, you got to go find a new CAD system.

So I think the general message was well received that Onshape has a great home within PTC. That's been a big success.

Now as it goes to cross-sell. I mean, honestly, it's too early. I do have a few anecdotal stories, but not enough to really draw any meaningful conclusions. But I would say this, we certainly think there are complementary use cases. For example, we're going to bring our AR technology close to Onshape, actually use much of the Onshape platform. And that will make that an easy cross-sell. And then we're off exploring coexistence strategies with Creo and Windchill as well so that we could both upsell from Onshape to Creo, Windchill and Vuforia but also cross-sell in those accounts to bring Onshape in for peripheral or, let's call it, edge use cases. So it's too early, though, to be honest. I'm very optimistic, but we've only owned it for about 2 months. And we're past the phase where people are looking for the bathroom, although we had to start over this week when they move to the headquarters. So -- but I mean it's just -- it's obviously too early.

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Operator [37]

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Next, we will hear from Adam Borg with Stifel.

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Adam Charles Borg, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [38]

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Maybe just talking a little bit more in AR. So you talked about augmented reality growing above market rates and some opportunities in PLM. But just wanted to dig in a little more on the cross-sell opportunity with IoT just given how complementary it is with ThingWorx. And maybe talk more about that cross-sell opportunity within the installed base.

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James E. Heppelmann, PTC Inc. - President, CEO, Member of National First Executive Advisory Board & Director [39]

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Yes. I mean I think you have to think about it as we're trying to connect the physical and digital worlds together like in our logo, right? And IoT is one form of connection and AR is another. And when you connect them together, you can then have AR experiences that contain IoT data. Meaning, I can use AR in the physical world to tell you about the physical world because I know about the physical world thanks to IoT. So these are definitely peas in a pod. It's a wonderful, beautiful combination. The products are very well integrated. In fact, if you remember, for a while, we called the Vuforia Studio, ThingWorx Studio. But these are very complementary technology. And what's really great, they're both best-in-class, and there is no other IoT company who has AR technology. And there's no other AR company who has IoT technology. So this is a very compelling story, and it's completely unique to PTC.

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Adam Charles Borg, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [40]

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Great. And maybe just as a quick follow-up. I think this year, you guys are focusing on increasing deal duration, both for new deals and renewals. And I was just curious, I know it's still early in the year, but what's customer receptivity towards that?

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Kristian P. Talvitie, PTC Inc. - Executive VP & CFO [41]

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Yes. I think it's early in the year to really comment on that, so we'll visit that later.

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Operator [42]

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Our next question comes from Sterling Auty with JPMorgan.

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Sterling Auty, JP Morgan Chase & Co, Research Division - Senior Analyst [43]

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Jim, you mentioned that nothing's really changed in the economic backdrop, that you're still dealing with the challenging PMI numbers. So with that as the constant, what would you say is the biggest change in the business? And based on your tone, are you suggesting that the core of the business -- sorry, I don't mean core, in that label, but the bulk of the business has fundamentally changed for the better? And if so, what are the main factors that have caused that?

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James E. Heppelmann, PTC Inc. - President, CEO, Member of National First Executive Advisory Board & Director [44]

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Yes. Okay. So yes, let me say, first of all, the PMI is what it is. It's not in a good place. And yet, we're in a good place. So clearly, something's changed. And I would submit that 2 things have changed. Number one, we've changed our business model and metrics, and we're a recurring revenue company versus a perpetual. And I want to come back to that. And then number two, we have a growth business. And as many growth businesses are, they're not cyclical. They're secular. Companies want to do digital transformation even when they're laying off workers. In fact, they might even connect those strategies together.

So I think the secular piece is very important. But frankly, it's overwhelmed by the business model change. And so if we go back to the great recession of 2009, let's review what happened to PTC. We had a perpetual stream of licenses, and we had a recurring stream of maintenance. The bottom fell out in the economy. The perpetual license sales declined, if I remember correctly, 32% in 2009. And what happened is the maintenance stream, which had been growing mid-single digits, basically went flat. And in 2010, it actually went down 2%. And after that, it grew every year since.

So what happened actually is the effect on a recurring revenue stream is very much muted. And you can see this in the sensitivity analysis we gave you some quarters ago where we showed you that for every 5 points that bookings drop, it would only bring ARR down 1 point. So if bookings dropped 30%, it would put 6 points of pressure on ARR. But that would be 2009 all over again. So we're in a situation where actually bookings aren't dropping. They're going up because of the secular thing. And therefore, ARR is going up with it. So I just think the days when PTC was highly correlated to PMI are simply behind us.

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Operator [45]

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Our next question comes from Steve Koenig with Wedbush Securities.

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Steven Richard Koenig, Wedbush Securities Inc., Research Division - MD [46]

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Congratulations on a very good quarter. So let's see, my question here is on the -- you had -- your revenue growth in your Growth business this quarter matched your ARR growth or actually maybe was a point above. And you mentioned that expansion deals were something like 2/3 of your IoT AR bookings. How did that latter metric compare with other quarters? And how is that trending? And more generally, do you expect revenue growth is going to be more at parity with bookings growth here going forward? And then I have a really quick housekeeping follow-up, if you don't mind.

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James E. Heppelmann, PTC Inc. - President, CEO, Member of National First Executive Advisory Board & Director [47]

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Yes. I can take part of that because I've commented on this many quarters. And it's always -- in many recent quarters, it's been in the 60-some percent range of new bookings was from expansions. So again, we've been following a land and expand model, which is a beautiful thing when you get it to work, and I think ours is really starting to work because you have a lot of accounts out there that you've sold, and they haven't contributed much to revenue, but then they come back and expand. And the expansions are really interesting, and they may come back several tranches of expansion. So that's been happening. We have many IoT and AR customers, in particular, who have come back one or more times for expansions. And I think I need to defer to Kristian if he can talk at all, explain the correlation between bookings and revenue growth rates. I think it's complicated.

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Kristian P. Talvitie, PTC Inc. - Executive VP & CFO [48]

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Yes, it's pretty complicated. It depends -- again, I'll just remind everybody, it depends a lot on start date. It depends on term length. It depends on renewal activity, et cetera. So not just term length of new deals, but term length of existing deals.

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James E. Heppelmann, PTC Inc. - President, CEO, Member of National First Executive Advisory Board & Director [49]

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Yes. Could I just interrupt? The real question isn't revenue but revenue recognition. So you get a booking, maybe you can recognize it, maybe you can't. Maybe it starts next month, which means next quarter. Maybe it's a ramp deal. So yes, it is a murky correlation between bookings growth and revenue growth.

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Kristian P. Talvitie, PTC Inc. - Executive VP & CFO [50]

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Yes, which is why we're trying to focus on ARR, which is kind of much cleaner and a better proxy in that sense in terms of cash generation for the business. And we still continue to expect the growth businesses to deliver north of market growth rates for fiscal '20. We would also expect there to be strong revenue growth [attendance] as well.

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Steven Richard Koenig, Wedbush Securities Inc., Research Division - MD [51]

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Okay. That's helpful. I guess maybe to recast that question a little bit. How are you seeing churn or the inverse, kind of renewal and expansion activity trending in that Growth business? And then I'll just toss out the housekeeping question here, which is your -- am I correct that your new ARR guide is now -- you're now giving that nominally, and that's 14% to 16%? But the comparison with 12% to 15% as your prior guide, the constant currency compare is 13% to 15%, is that right?

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Kristian P. Talvitie, PTC Inc. - Executive VP & CFO [52]

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That's correct. Yes, we tightened up the low end of the range and then raised the entire range because of FX. 100% agree. Then in terms of churn, we continue to see churn in the growth businesses higher than in the Core and FSG from a percentage perspective. And we also continue to expect that, that will trend down over time.

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James E. Heppelmann, PTC Inc. - President, CEO, Member of National First Executive Advisory Board & Director [53]

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So yes, it has been improving consistently for a long period of time, and we expect that to continue.

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Kristian P. Talvitie, PTC Inc. - Executive VP & CFO [54]

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Yes. So I don't think there's anything notable really to point out there other than those factors remain.

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Operator [55]

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Next, we will hear from Yun Kim with Rosenblatt Securities.

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Yun Suk Kim, Rosenblatt Securities Inc., Research Division - Senior Software Research Analyst [56]

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Congrats on a solid quarter. I just want to talk about some of the ASP trends that you may be seeing out there. Obviously, you guys talked about ASP trend. I'm assuming it's increasing in the Growth products group. How is that ASP trending versus your Core products group? And obviously, Jim, you talked about land and expand model working very well. Has that minimized the overall percent of business coming from large deals despite, I am assuming, increased ASP coming from your Growth business?

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James E. Heppelmann, PTC Inc. - President, CEO, Member of National First Executive Advisory Board & Director [57]

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Okay. By ASP, you really mean deal size, transaction size?

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Yun Suk Kim, Rosenblatt Securities Inc., Research Division - Senior Software Research Analyst [58]

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Yes, exactly.

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James E. Heppelmann, PTC Inc. - President, CEO, Member of National First Executive Advisory Board & Director [59]

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Yes. I mean average deal size in the Growth business, I'd have to check because while we're getting more big deals, we're also getting more small deals. So I'm not convinced -- I don't have the data in front of me. But my intuition would be ASP is actually not changing much. But of course, the business is growing fast.

And then in any case, it would generally be smaller than the Core business because of this land and expand motion that we adopted in the Growth business and didn't really adopt so much ever in the Core business. So the Core business tends to be bigger transactions, although there's a lot of add-ons of modules here and there. But PLM, for example, would tend to have larger ASPs because there's not really a land and expand model.

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Yun Suk Kim, Rosenblatt Securities Inc., Research Division - Senior Software Research Analyst [60]

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Got it. Okay, that makes sense.

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James E. Heppelmann, PTC Inc. - President, CEO, Member of National First Executive Advisory Board & Director [61]

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Sorry, that's not a perfect answer. But hopefully...

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Kristian P. Talvitie, PTC Inc. - Executive VP & CFO [62]

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Although smaller than they were when they were perpetual.

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James E. Heppelmann, PTC Inc. - President, CEO, Member of National First Executive Advisory Board & Director [63]

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Oh, yes. For sure.

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Yun Suk Kim, Rosenblatt Securities Inc., Research Division - Senior Software Research Analyst [64]

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Okay. Great. And Jim, also real quick question around more of a thematic stuff. So I'm not sure if you're running into this, but we are hearing a lot about 5G technology potentially accelerating the market adoption of IoT out there especially in the factory automation market. Do you see that or do you expect 5G technology to be meaningful for you in your IoT business? Or is it too early to tell?

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James E. Heppelmann, PTC Inc. - President, CEO, Member of National First Executive Advisory Board & Director [65]

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Well, I definitely think it's important to our IoT customers. It's too early to know if it would cause our business to grow faster or not. But certainly in factories, people want to adopt 5G to have high speed, low latency wireless communications for their machines and their augmented reality devices and so forth. So it's definitely important. And I can tell you, we are engaged in discussions with several different 5G partners. I think one of them might end up being a big sponsor of LiveWorx. And I see it at this point as an ecosystem play, which is I want to make sure that 5G companies help promote our IoT technology and that our IoT technology can create opportunities for 5G companies and so forth. I think it's too early to say it's an accelerator, but it's definitely important.

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Operator [66]

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Our next question comes from Jason Celino with KeyBanc Capital Markets.

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Jason Vincent Celino, KeyBanc Capital Markets Inc., Research Division - Associate [67]

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It looks like expense growth in the quarter was around 5%, but I think you guys are guiding more to 9% growth for the full year. Can you just talk about what are maybe some of the other big investments that you'll be making or integration costs as we kind of go through the year?

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Kristian P. Talvitie, PTC Inc. - Executive VP & CFO [68]

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Yes. So I think expense growth has a little bit to do with timing of Onshape, right, as we only had a couple of months in the quarter. So we didn't have the full quarter's worth of Onshape. And then there's the kind of normal hiring plan. And we do have some back-end loading to that hiring plan.

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Operator [69]

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Next, we will hear from Alex Tout with Deutsche Bank.

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Alexander William Tout, Deutsche Bank AG, Research Division - Research Analyst [70]

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Yes. I'd just be interested in your comments on the automotive end markets, specifically, it seems like it's probably one of the most, if not the most, challenged manufacturing end market at the moment. I know your exposure isn't huge. But we're interested to see what you're seeing in terms of -- because I guess, on the one hand, you have secular and cyclical challenges in that industry versus also a need to innovate at the same time. So what's kind of the net of those dynamics that you're seeing in your customers in the automotive space right now?

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James E. Heppelmann, PTC Inc. - President, CEO, Member of National First Executive Advisory Board & Director [71]

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Yes. We're seeing actually relatively strong demand for IoT factory projects because I think in a downturn, people are looking for efficiency. And taking a dumb factory and making it smart ought to make it, most people would believe, 5%, 10%, 15% more efficient. And across the level of spend that people have in their production processes, those are very big numbers. So IoT demand is good.

And then I'd also say PLM demand is good. I mentioned a truck company. There's another big European automotive OEM where we're working on some big PLM projects and probably looking at an expansion on that to a next phase pretty soon and so forth. So I think the PLM is really coming from digital transformation. And IoT is coming from let's try to find more productivity in our factories.

I would say, CAD, not so much. Probably, we're not getting a lot of demand on the CAD front right now but good demand for PLM and IoT.

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Operator [72]

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Our next question comes from Tyler Radke with Citi.

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Tyler Maverick Radke, Citigroup Inc, Research Division - Senior Associate [73]

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It looked like on the guidance, you -- the guidance raise on most metrics was driven by a combination of currency as well as solid execution in the quarter. The one line item that didn't see a raise appeared to be free cash flow. Maybe just help us understand why, given the solid fundamental performance in the quarter and your improved outlook on the year, why you're not expecting more free cash flow than you've previously guided?

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Kristian P. Talvitie, PTC Inc. - Executive VP & CFO [74]

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Yes. Sure. So I think we should look at both adjusted free cash flow and free cash flow. And I'll start with just free cash flow first. So we did take the adjusted free cash flow up for currency. Free cash flow, we did not. Just highlighting, we put it in the prepared remarks. But when we put out the initial restructuring estimate for the year, that was based on an estimate. Current estimates actually have that about $5 million higher. So that actually offsets the favorable currency impact on free cash flow. For adjusted free cash flow, we did raise that by $5 million, which again is largely the FX impact. And what I would say here is it's just early in the year, and we're just being prudent. Of course, we'll revisit this as we continue to move through the year. But that's the answer.

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Operator [75]

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That is all the time that we have for questions. Please remain on the line for Tim Fox's closing remarks.

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Timothy M. Fox, PTC Inc. - VP of IR [76]

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Thanks, Sheila, and thanks, everybody, for joining us today on the call. PTC is going to be participating in 3 conferences in March, starting with Morgan Stanley's Global TMT Conference in San Francisco, followed by Berenberg's Design Conference and RBC's one-on-one conference, both in New York. And additionally, we're going to be sending a save the date for our 2020 LiveWorx event, which will be here in Boston, of course, from June 8 to 11. So watch that in your inbox. And so we look forward to seeing you on the conference circuit in the coming months. And if not, we'll be sure to update you on our Q2 call in April.

Again, thank you for your interest in PTC, and have a great evening, everyone.

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James E. Heppelmann, PTC Inc. - President, CEO, Member of National First Executive Advisory Board & Director [77]

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Yes. Thanks, everybody.

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Kristian P. Talvitie, PTC Inc. - Executive VP & CFO [78]

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Thank you.

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James E. Heppelmann, PTC Inc. - President, CEO, Member of National First Executive Advisory Board & Director [79]

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Bye-bye.

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Operator [80]

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That concludes today's conference. Thank you for participating. You may disconnect at this time.